Interest Rates | Inflation | Bond Market | decoded for beginners - Everything to know about

As interest rates have peaked globally, bond as an asset class is going to take center stage in the discussions about investments.

But why? Let's understand.

Before jumping to the Bond market let's set the background first.

Up till now, to control inflation, Central Banks around the world were increasing interest rates.

For starters, inflation in its most simple form is the rise in general price levels.

Why does inflation occur?

Because either there is too much money supply in the system trying to buy available goods or there is shortage of goods as compared to the market demand.

And we globally faced inflation because of both of the above scenarios happening in different parts of the world.

To control the Inflation, Central Banks globally increased interest rates - basically making the money costlier for everyone thus leading to less demand for money as well as goods.

Now as the inflation is somewhat under control globally with few exceptions, the global view is turning towards a falling interest rate scenario, because high interest rates for too long hampers economic growth.

So Central Banks are expected to pivot towards lower interest rates.

What are bonds?

Bond is a financial instrument issued by either a government or corporation to borrow funds for projects or operations and in return provides coupon(interest) and at maturity returns the principal.

Above is an example of a simple bond, there are numerous variants.

Now when interest rates are rising, new supply of bonds in the market keeps taking place at higher rates thus making existing bonds with lower rates less lucrative for investors.

Because as new bonds come in the market at higher rates, the existing bonds issued when interest rates were lower giving lower returns will not be in demand by investors.

But now as interest rates globally are expected to fall, the reverse is expected to happen.

The existing bonds with higher rates will be in more demand thus making the bonds market lucrative.

So investors would like to buy long term bonds currently as interest rates are at peak to lock in high interest rates for the foreseeable future as against the upcoming supply of bonds at lower interest rates when Central Banks will start decreasing.

Thus the bond market will be the center of discussion globally.

We will discuss more on the same in coming posts.

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